Post-Election Fiscal Choices, Economics, & the Defense Budget

Over the next few weeks, the Administration and the Congress will be making key decisions regarding the Fiscal Year 2013 Defense Program (FYDP), as well as our future tax structure. With the elections in the rear view mirror, the outlines of the eventual resolution may not be readily apparent, but they are certainly clearer than beforehand.

While there is likely to be a good deal of back and forth in the weeks ahead, the most significant figure for the Defense Department will be the bottom line on the FY13 Defense Appropriations Act. This assumes, of course, that there will be an Appropriations Act, and that DoD will not be on a continuing resolution beyond the next several months. The FY 13 request that is still pending on the Hill was for a base budget of $525bn, plus $88bn for Overseas Contingency Operations (OCO). This reflects only a modest drop in the base program (from $530bn in FY12), but OCO declines from $115bn to $88bn, and thus the aggregate ’13 program would reflect a decline from $645bn to $613bn. Negotiations between the White House and the Hill are likely to support spending approaching the $613bn figure, not in the least since the House bill passed in July (awaiting conference after eventual passage of a Senate bill), called for a total outlay of $605bn.

It is important to remember, as these discussions are taking place, that future “cuts” in the Defense budget in the out years are calculated against projections in the FY 12 program, which called for steady increases over the FYDP. For example, the proposed Defense budget currently on the Hill calls for an increase from $525bn in FY 13 to $534bn in FY 14. However, since the earlier (i.e. FY12) program had called for $587bn in FY 14, this is considered a “cut” of $53bn, even though the base program is actually increasing by $9bn. DoD has been transparent in demonstrating how these calculations are made; it’s just important to understand how the math works. Moreover, we need to take a deep breath and recognize that the post-Budget Control Act/pre-sequester program actually calls for increases in the base Defense budget over the FYDP (from $525bn in FY 13 to $567bn in FY 17), which most people would not regard as a “cut.”

Of course, much of this is driven by non-Defense Federal spending and overall Federal tax revenue as a percentage of GDP. Regardless of individual opinions about the tax code, we cannot resource Federal programs at reasonable rates and keep the deficit at acceptable levels with current revenue. For context, during the period 1972-2003, Federal revenues averaged approximately 18% of GDP. If managed effectively, this base can provide a sound Defense program, a reasonable level of entitlements, and a manageable annual deficit. However, we are currently hovering at around 15-15.5% revenue as a percentage of GDP, which is simply not enough to sustain equilibrium.

The larger issue is the opportunity cost for the Defense Department and partners in industry because of the extended period of fiscal uncertainty. The DoD only so much capacity for program planning and assessment, and the demands of balancing short-term execution from long-term planning (and re-planning) are very difficult to resolve. The current disorder has detracted greatly from stable, sustained and efficient program planning and execution, both in the government and the private sector. The only silver lining in this cloud is that the Defense financial managers and comptrollers have had so much experience coping with continuing resolutions over the past ten years or so, that the government system is proficient at dealing with uncertainty, particularly in the initial months of the fiscal year. However, this does not mitigate the large-scale public and private sector inefficiencies (verging on waste) caused by an inability to focus on long-term, deliberate financial planning.

In summary, we should all hope that the outcome between now and early January will serve as the basis for a sustained period of prudent and predictable resources and program planning for DoD, and an end to the incremental approach that has stymied us for the last several years. This is critical for our overall security posture, and moreover, we owe it to the American taxpayer.